Conventional v Islamic Loan

The Differences Between a Conventional and Islamic Housing Loan and the Consequences of Default

Regardless of whether you are a Malaysian or a foreigner, you are spoiled with choices of housing loans offered by banks in Malaysia, tailored depending on your needs. Most banks in Malaysia offer both Conventional and Islamic Housing Loan. How then would you choose between the two and what are the differences?

Conventional Housing Loan

A Conventional Housing Loan is pretty straightforward. The Bank acts as Lender, lends money to the Customer, who intends to finance the purchase of a house. As a security, the Bank takes the house as a collateral. When the Customer has paid the money in full at the end of the loan tenure, the Bank returns the house to the Customer. To earn profit from such lending, the Bank charges interest rates on the principal amount. The interest rate can be fixed or based on a floating rate depending on the Base Lending Rate imposed by the Bank Negara Malaysia.

Islamic Housing Loan

An Islamic Housing Loan is a part of Islamic Finance and is a concept derived from the Al-Quran. According to this concept, the act of interest charging is not allowed. Only trade is allowed, which forms the foundation of Islamic Financing. Thus, under an Islamic Housing Loan, the Bank buys a property on the Customer’s behalf and sells it back to the same at a profit. The profit rate can also be fixed or floating. The main types of Islamic housing loan in Malaysia today are the Bai Bithamin Ajil (BBA) and Musyarakah Mutanaqisah (MM) concept.

BBA is one of the earliest Islamic Housing Loan concept in Malaysia and it literally means “buy and then, followed by a sale”. The Bank will buy the property of your choice and sell it back to you at a profit which the price will be required to be paid by monthly instalment. The word “loan” and “interest” are not applied in this context. Like a conventional loan, the Customer will need to pay monthly instalments over a period of tenure.

MM on the other hand means “diminishing partnership”. Under this concept, the Customer and the Bank enters into a partnership to purchase a property. The Customer pays rent to the Bank as a tenant and money to buy the Bank’s share in the property i.e. the monthly instalment which the Customer is required to pay over the tenure. When the bank has been paid in full, the ownership of the property will be vested with the Customer.

Differences between Conventional Housing Loan and Islamic Housing Loan

The main difference between a Conventional Housing Loan and Islamic Housing Loan is the concept of interest. As mentioned earlier for Islamic Housing Loan, the Bank will set a contract based on the future price of the property depending on the valuation and the Customer is required to pay the price by monthly instalment. The price is fixed much earlier at the start of the contract when the Customer takes up the loan. Thus, the Customer does not need to worry about fluctuating interest rates as opposed to that of the Conventional Housing Loan. Even in the context of a floating profit rate, there is a maximum cap which the bank cannot exceed.

The other difference is the concept of sharing risks as demonstrated in MM where the Bank and the Customer shares partnership in owning the property. Although the Bank does not carry out the obligations of a proprietor in practice, the Bank does feel the burden such as in the case of natural disaster or when the Customer defaults in the repayment of the loan. This differs from a Conventional Housing Loan where the Customer bears full risk of the property and paying back the loan.

Although Islamic Housing Loan is also made available to non-Muslims, it must be noted that the Bank will not approve of your loan if the financing is for non-halal purposes. The same applies to the occupation of the Customer. However, there is no such “halal” requirement in Conventional Housing Loans.

Apart from that, it is also said that Conventional Housing Loans are more transparent compared to the Islamic Housing Loan. Any costs for early settlement, late payments or defaults are clearly stipulated in the loan agreement with the Bank.

In terms of documentation, Islamic Housing Loan consists of more agreements as it involves the contract to purchase the property and subsequently the sale of the property to the Customer. In the case where the Customer wishes to change the terms or the amount of loan, a new set of Sale of Property and Purchase of Property Agreement will need to be drawn up and stamped. As for the Conventional Housing Loan, there is only one Facility Agreement and need only be up-stamped when there are changes. This implies that Islamic Housing Loans might incur more legal costs. However, Islamic financing products in Malaysia does enjoy 20 percent discount on stamp duty.

What is then the Consequences of Default?

Under the terms and conditions of the Loan Agreement, it is agreed that the Customer shall pay instalment over an agreed tenure at an agreed margin or interest rate. If, however, the Customer has failed to make payments as scheduled, each bank will exhaust their own procedure of recovering the debt from the Customer.

In practice, upon knowledge of any late payment in instalment, the Bank will issue automated reminders to recover the arrears. This will normally be followed by attempts of personal contact by the Bank to inquire on the reasons for such default. If the situation persist for more than 6 months, the Bank will proceed with the litigation process to recover the arrears. In this instance, the Bank will instruct its panel lawyer to issue a letter of demand. Subsequently, letters to recall the facility and to issue a summon for the Customer to appear before the court. Unless the Customer can prove his case before the judge on why he is unable to serve the instalments, upon obtaining a judgment from the court by the lawyer, the Bank has the right to execute its judgment. It is important to bear in mind that having not enough money is not a good defence for defaulting a payment.

If the bank is unable to recover the debts owed by the Customer, the bank will then proceed with foreclosure proceedings. It is for the Bank to recover the loan obtained by the Customer and also to recover the costs of litigation. If there is any excess money from the sale of the property after deducting all necessary costs owed to the Bank, the Bank will return the same to the Customer. If, however the proceeds from the sale is insufficient, the Bank has the right to recover any due payment from the Customer. This could potentially result in a bankruptcy proceeding instigated against the Customer if the same is unable to repay the money to the bank.

Now that you know the types of loan that is offered by banks in Malaysia and the consequences of default, it will be much easier for you to determine on which type of financing to take. It is also important to weigh on your own ability to commit to the repayment of a loan as maintaining a good credit record is crucial. With the advancement of technology and its application, it is not at all hard to inquire into your CCRIS and CTOS report if one does so. In all, there is no fixed rules as to which type of loan is the best for you. It depends on you, your situation, and your needs.

If you have any questions or require any additional information, please contact our lawyer that you usually deal with.